Is the policy rate rising too high, too quickly?

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Is the policy rate rising too high, too fast?

While the Bank of Canada has just raised its key rate again by 50 basis points to 3.75%, a sixth increase in 2022, critics are more more vivid. What will be the impact on households? Is the institution going too far, too fast?

The Bank of Canada tries to control the inflation.

Earlier this week, the leader of the NDP, Jagmeet Singh, threw a stone into the pond. According to him, the Bank of Canada is using “too aggressive” measures and risks causing an “imminent recession”. Canada is incidentally the G7 country to have increased its key rate the fastest.

This one-size-fits-all solution to inflation is already laying the groundwork for a recession and making life difficult for most people, he wrote to Prime Minister Justin Trudeau.

He is not the only one to criticize the central bank. During the leadership race, the leader of the Conservative Party of Canada, Pierre Poilievre, promised that he would fire the governor of the Bank of Canada, Tiff Macklem.

These criticisms also have their echoes elsewhere in the world. In Finland, Prime Minister Sanna Marin retweeted a link to an article that claimed central banks are protecting their credibility by plunging economies into recession. The former Nobel economist, the American Joseph Stiglitz, describes the current measures as bloodletting which risks worsening the situation even more.

Too fast and poorly suited, some say

In an interview at Economy Zone with Gérald Fillion, independent senator and economist Diane Bellemare added her voice to the debate. According to her, the Bank of Canada is moving too fast and risks hurting Canadian households.

Interest rates had to be raised. [However] I think they are increasing too quickly. […] In the current context where there are many uncertainties, the increase should be slower and more gradual, she indicated.

Ms. Bellemare says the current inflation has more to do with supply, the supply chain and the war in Ukraine than demand. She therefore believes that the Bank of Canada's monetary policy, which aims to curb the latter by raising interest rates, is not the right one.

When there is demand-driven inflation, monetary policy is appropriate. But when you have inflation by supply, by supply chains, as we currently know, it is a tool that must be handled with great skill.

This is also what researcher Guillaume Hébert, of the Institute for Socioeconomic Research and Information (IRIS), believes in an interview with Radio-Canada.

They are practically bringing out their only tool to tame inflation, but unfortunately it is the cure that may be worse than the disease. It might not work, because the policy rate seeks to stifle demand and the problems are more on the supply side, he imagined.

The economist and senator Clément Gignac is more nuanced. He believes that current inflation is also driven by demand.

In the beginning, if you go back to a year, a year and a half ago, it was mainly supply that was the cause of the surge in inflation, but I think excess demand is starting to play a big role, he said.

Economist Clément Gignac.

Mr. Gignac in fact believes that the Bank of Canada has unnecessarily delayed raising its rates and that it was necessary to act as soon as inflation showed up in 2021. But he is pleased that; she finally acted with vigor.

I was one of those who said that the Bank of Canada expected too much. As we speak, I think to myself: better late than never. Because if we don't attack inflation in a solid and decisive way, we will repeat the mistakes of the 1970s, which led to even worse problems.

Louis Lévesque, President of the Public Policy Committee of the Association of Quebec Economists, made the same reading.

In the 1970s and 1980s, inflation was brought under control, but not without suffering. It was 12%, 13% per year; significant efforts have been made. Low and predictable inflation is a great advantage for households, businesses, for governments, he says.

However, given the current situation and the uncertainties, Diane Bellemare would be in favor of reviewing and clarifying the mandate of the Bank of Canada. Canada should adopt a dual mandate* as other countries have done, such as New Zealand, Australia, the United States, she stresses.

Clément Gignac is not against it, but considers it wiser to wait a few years before considering such a project. When you're in the middle of a storm, is it really time to tell the captain to change course? I don't think so.

The problem for IRIS is that Bank of Canada policies are not neutral and generally favor the wealthy. A society where interest rates are higher is a transfer of wealth to banks and financial institutions, assesses researcher Guillaume Hébert.

However, there is one certainty. With this new rate hike, households will have to review their budget, because it will cost more to borrow, for mortgage rates or lines of credit.

Not to mention that the measures from the Bank of Canada could push Canada into a recession.

We don't have a crystal ball… but the economy is operating above its potential right now. It must be brought back to its potential, believes Louis Lévesque. And it must be done gradually to avoid a major recession. But according to the indicators, if there is a slowdown, it will be mild, there will not be a significant increase in unemployment, because underlying demand is strong.

I can't wait to see if, with such a rate, it's enough to overcome inflation without creating a recession. And this would not be an ordinary recession. We will not see the unemployment rate increase from 2% to 3%, believes Clément Gignac.

Moreover, the latter believes that the current economic situation is not bad, despite the slowdown in certain sectors such as real estate. Households have a lot of money, the job market is still very tight, he maintains.

But for other economists, a recession could have even more harmful impacts than inflation.

Recession is worse than inflation. A recession could put workers in a weak position vis-à-vis employers, because in the current situation, the scarcity of labour, they still have a balance of power, believes Guillaume Hébert of IRIS.

Rising rates have an impact on mortgage loans, but also on rents possibly, but also on investments. It creates a slowing effect, also underlines Ms. Bellemare.

Clément Gignac is rather of the opinion that a recession has a less significant impact than inflation on households low income. The poorest are proportionally more affected than the better off by inflation. They are often less homeowners and groceries, food, transport, housing, it is a larger proportion of their expenses.

*Some central banks have a dual mandate : price stabilization and the labor market.

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